Negative, neutral, positive gearing: Which is best?
Tax law in Australia is inherently complex. When it comes to people's finances and investing, as an ever-evolving beast, a change in one area of tax law has implications across many other areas.
Negative gearing is one of these areas, and it's been a hot topic in recent years. Deciding whether your property will be negatively, neutrally or positively geared is a critical consideration when you're structuring your investments. Below, we take a look at each and what you should consider.
What is gearing of an investment property?
The gearing of an investment property refers to the borrowing and interest deductions associated with the investment. The way you structure your investment will impact your bottom line, so you need to understand each scenario and talk to an accountant to help you decide what's right for your unique situation.
What is negative gearing?
When the deductions claimed on a property are more than the annual rental income, the property is negatively geared. It means there is a tax loss for the property at the end of the financial year.
What is neutral gearing?
Neutral gearing means the income and expenses on a property are balanced. It will not affect your taxable income.
What is positive gearing?
When the rental income from a property is more than the deductions claimed, the property is positively geared and adds taxable income to the taxpayer.
Which option is best?
In short, it depends on your situation. Some investors prefer negative gearing due to the tax loss that can be offset against their taxable income. On the downside, it means the property's rental income isn't enough to cover what could be considerable monthly expenses. While it may feel like a bonus at tax time, it can be a drain on your cash flow throughout the year.
Positive gearing provides cash flow to the investor, but there will be income tax implications at tax time. You'll need to work with your accountant to forecast your current and future taxable income (PAYG, investment properties and other income) to determine what effect positive gearing will have on your marginal tax rate.
Determine your goals and speak to a professional
The choice to implement negative, neutral or positive gearing will depend on your unique financial situation and goals. Make sure you speak to your accountant for tailored advice to make an informed decision.
Remember, this article does not constitute financial or legal advice. Please consult your professional financial and legal advisors before making any decisions for yourself.